Unabashed caveat: I will be facilitating a talk on the Business of Customer Success at the Customer Success Association Conference in Seattle on August 18, 2016. This post will help solidify the overall layout and will hopefully serve as reference material for those in attendance. Brace yourselves… it’s a long one.
Before we get lost in the details, it helps to take a step back and remember the basic steps to design, implement and monitor your Customer Success (“CS“) organization.
- Define the value proposition for your CS team (cost reduction, revenue generation and risk reduction, etc.).
- Baseline your current state of KPIs
- Select set of desired business outcomes
- Identify the drivers to meet your business outcomes and track them as you implement.
If/when you get lost, always come back to these steps for guidance.
Customer Success Value Proposition
Similar to your production solution, the key to CS is to first understand its value proposition, then promote and defend it vigorously. At the core, this means understanding CS’ impact on 1) revenue generation, 2) cost reduction and 3) risk reduction.
Customer Success is a revenue center – even more so, a revenue driver. Your long-term focus has got to be on how to achieve net negative revenue churn (negative churn) as well as work to identify 2nd order revenue impacts to Customer Lifetime Value.
To start, focus on developing plays to identify cross-sell and upsell opportunities as well as expansion opportunities that deliver additional value to your customer. Be sure to align CSM compensation to these goals to get better traction and commitment. When the time is right, consider adding a premium, paid Customer Success offer to your services mix. Enterprise customers will expect some heavier services contracts and will not be afraid to pay for it.
Scalable Customer Success lowers operational cost through effective use of technology as well as lowering the effective cost of sales through expansion tactics. When putting together CSM/ARR and Sale Quota targets, remember to leverage technology to increase account responsibility numbers without sacrificing the level of touch you desire for each customer segment.
Lastly, do not overlook the ability of CS to mitigate those “surprise” cancellations as well as maintain a good product-market fit as the market changes. While this is a harder metric to quantify, it should be considered and elevated in your pitch to upper management for additional CS resources.
Basic Customer Success Business Metrics
As Peter Drucker said, “If you can’t measure it, you can’t improve it.” To understand and improve the business of CS, you need to come to an agreement on which metrics to measure and how those metrics are measured. Most are familiar with MRR/ARR, Customer Acquisition Costs (CAC), Payback Period and Churn Rate, but there is less clarity around Customer Retention Costs (CRC), CS Magic Number and Customer Lifetime Value.
Revenue Source Tracking
It is important to break out and trend the various sources of revenue (ARR/MRR), namely:
- starting revenue
- churned revenue
- downsell revenue
- upsell revenue
- cross-sell revenue
- expansion revenue
By breaking these out and tracking retention/expansion/churn rates for each, you can get a better indication of what is driving your MRR/ARR growth as well as spot areas where you can improve. The TSIA recently performed a study on CS’s ability to reduce the effective cost of sales through strong expansion tactics.
I highly recommend their XaaS Playbook to really get into the nitty gritty details of what drives profitable SaaS business models.
The critical first element of SaaS profitability is having a keen focus on Customer Acquisition Costs (CAC). This is the total cost of your sales and marketing efforts to land one new customer. If this is a new metric to your organization, work with your finance and sales department to calculate and trend it over time. Once you have your CAC computed, you can determine the payback period for a new customer:
This rough calculation should be an indication of how fast you are able to recoup the initial S&M investment. Rule of thumb is that this should be < 12 months.
Customer Lifetime Value
Customer Lifetime Value (CLV) is a measure of the net present value of all revenues you expect to receive from your average customer. By knowing this value, your S&M and CS investments are easier to justify. However, calculating an accurate CLV can get complicated and depends upon your churn situation.
For organizations that have not yet achieved net revenue negative churn, the calculation is a bit easier. First we determine the average lifetime of the customer:
Then we sum of the present value of the gross margin payments using our company’s agreed upon discount rate:
For organizations that have achieved net revenue negative churn, we need to get a bit more complicated and make some generalizations. Essentially, it comes down to assuming an average growth rate “G” for your expansion revenue per account and constant, “K”, that takes into account your customer churn rate and discount rate.
Most finance departments can tell you the company accepted cost of capital. If not,Dave Skok recommends using the following rules of thumb depending upon your situation:
- 10% for public companies
- 15% for private companies with predictable scale
- 20-25% for private companies without predictable scale
It is important to note that rates, gross margins, average account revenue growth and cost of capital will change over time. Update your model accordingly.
Customer Success Magic Number (Efficiency Ratio)
The Customer Success Magic Number is analogous to the Sales Efficiency Number and gives insight to the effectiveness of your CS team.
The magic number will show you the amount of revenue being achieved per dollar of Customer Retention Costs. As a rough rule of thumb, this ratio should be greater than or equal to 5. Or inversely, a $0.20 cost should retain $1 of recurring revenue.
Select Set of Business Outcomes
Your chosen business outcomes will be the drivers of your model and must be quantitative and realistic.
- Attain 120% Net Revenue Churn
- Reduce logo churn to under 10% per year
- Increase premium CSM offer acceptance rate by 10%
Justifying the Customer Success Investment Strategy
There are many different variables that will impact your pro-forma analysis on the ROI of Customer Success. I have put together a simple CS Investment Excel Model to help make the analysis easier. Keep in mind this only assumes one segment of customers and CSMs. Feel free to adapt this model to fit your particular segmentation and engagement model. This model takes heavy cues from Christoph Janz’s excellent full SaaS business model spreadsheet as well as Dave Skok’s CLV model. Please feel free to point out any errors and I will update as necessary.
To get you started with this model, let’s review a growth stage SaaS company with MRR of $200k and a desire to grow their MRR 250% YOY with a 2.5% churn rate and a 0.5% downsell rate.
As seen above, without any CS efforts, churn is unacceptably high and results in a CLV of $24.6k at a 10% discount rate. Most companies are able to achieve an annual churn rate of less than 10% after implementing CS. When these targets are placed into the model, CLV rises to $58k. Beyond the revenue increase, we need to estimate the present value of all CRC over the life of the customer and determine the ROI for our CS efforts:
Even without any revenue tactics, ROI is found to be over 150%. When value adding revenue targets are set with your CS team, the impact becomes even more evident.
Let’s review that same company, this time with a negative monthly churn rate target of 101%.
By adding small revenue expansion goals to the CS team, we were able to more than double CLV and increase CS ROI to 562%.
The financial metrics presented in this article are not the drivers of customer success. They are lagging indicators of the repeatable, scalable processes that you implement to make wildly successful customers. This model is only as good as your assumptions and your ability to track, iterate and find good talent to hit your goals. Don’t worry, you won’t get it right at first! Just keep iterating and CS will be the reason for your company’s long-term profitability.